Memorandum submitted by Dr Mushtaq Husain
Khan, Department of Economics, SOAS, University of London

BACKGROUNDTOTHIS SUBMISSION

In 1998 the Norwegian Foreign Ministry and NORAD
commissioned a study to investigate the impact of governance failures,
including corruption and the operation of Palestinian institutions
on Palestinian state formation. This was in the context of Norwegian
aid support to the Palestinian Authority and its sponsorship of
the Oslo Process. Three people led the research team: myself,
based at SOAS, Dr Inge Amundsen, a political scientist based at
the Christen Michelsen Institute (CMI) located in Bergen, Norway,
and Dr George Giacaman, a Palestinian sociologist based at Muwatin,
a research institute based in Ramallah in Palestine. A further
eight researchers were part of the team, from the CMI and SOAS,
but mostly commissioned from Palestinian universities by Muwatin,
in Palestine. The project became a wide-ranging investigation
of the constraints facing state formation in Palestine and the
team kept working until 2002. The report has taken the shape of
a book that is being published by Routledge early next year.

SUMMARY

The Oslo Agreement intended to set up a Palestinian
client state; the evidence suggests that both sides broadly accepted
the limits of this state, even though neither would refer to it
as a client state for obvious reasons. Israel's insistence on
a client state was driven by its security concerns, but it could
only be made effective either by creating incentives for compliance
through economic integration or severe penalties for non-compliance
through asymmetric controls over the Palestinian economy. Israel
started with the former objective in its declarations but its
actions very soon could only be described as consistent with the
latter. We argue that this can in turn be explained by Israel's
demographic concerns with economic integration. We argue that
many of the governance failures of the Palestinian Authority can
be explained in terms of the design features of the Oslo Agreement.
Other apparent failures were paradoxically developmental interventions
that successfully attracted overseas Palestinian investors by
offering them non-transparent benefits in a context of great uncertainty.
A third category of governance failures reflected genuine failures
of the Authority. Our analysis directs attention to features of
Palestinian governance that need attention in the future, but
also points to the importance of external donors having a clear
idea of what a viable Palestinian state would require before they
engage in conflict resolution. This was missing in Oslo, and is
particularly important now that Israel seems to have adopted a
"bantustanisation" strategy that is likely to create
lasting problems for a two-state solution, and which is ironically
not in Israel's interests either.

FRAMEWORKOF
ANALYSIS

The Palestinian Authority was not a state, and
lacked many of the critical powers of a state. It did not have
control over its borders, currency, fiscal or monetary policy,
natural resources, or foreign policy, it did not determine citizenship,
and much of its trade was with or through Israel and regulated
tightly by the Paris Economic Protocol. On the other hand, it
was somewhat more than a municipal government. It had policing
and security powers over Palestinians, and most Palestinians recognised
its exercise of lethal force over themselves as legitimate. Its
leaders also had access to budgetary (and off-budget) resources,
which were used for political accommodation and stabilisation
within the Palestinian polity, and this gave it a state-like quality.
And despite the absence of any formal powers to determine property
rights, its leaders had the political legitimacy to sign economic
"contracts" with overseas Palestinian investors with
sufficient credibility to encourage many of them to invest in
a context of great uncertainty. These characteristics meant that
any analysis of governance would have to take into account the
specific context in which Palestinian state formation was happening.
In particular, the Authority had a number of contradictory
state characteristics in incipient form, and we wanted to identify
the internal and external conditions that would encourage the
further development of particular combinations of characteristics.

A further complication for assessing performance
is that the Palestinian economy was highly dependent on the Israeli
one. Part of this was a natural dependence given the much greater
degree of capitalist development in Israel and the availability
of labour market opportunities there, but part of it was an engineered
dependence, based on artificial controls over trade, investments,
fiscal space, and of course, restrictions of movement within
the Palestinian territories through settlements and checkpoints.
As a result, the Palestinian economy was hugely dependent on the
performance of the Israeli economy, and more importantly, it could
be made to suffer if Israel took particular actions like limiting
the flow of labour to Israel or cutting off parts of the Palestinian
territories from each other.

The following table shows that as soon as Oslo
was signed, the Gross Domestic Product (GDP) of the Palestinian
territories collapsed, and this was largely because Israel imposed
new "border controls" between Israel and the Palestinian
territories, and within the Palestinian territories. The fall
in Gross National Income (GNI), which includes labour remittances,
was thus even more severe than the fall in GDP. This relationship
between GNI and GDP is a persistent feature of the Palestinian
economy and is an index of its dependence on labour flows to Israel.
This can be seen in the first two rows of the table. In downturns,
GNI falls more than GDP, and in upturns, it rises by more.

After the first two years of adjustment, GNI
strongly recovered. This was because labour was once again allowed
into Israel, but now in the context of a system of controls that
could be used to stop movements at short notice. But what is more
interesting is that growth of GDP shot up as well. Unfortunately,
this round of the state-formation exercise abruptly ended in 2000.
The figures for the succeeding period are being constantly revised
downwards and are less trustworthy, but there is no question that
the Palestinian economy has been destroyed during the second intifada.
We can explain the growth spurt from 1996 to 1999, and in particular
the strong GDP growth, in terms of the strong recovery in private
sector investment, as shown in the third row of the table.
Since the local Palestinian private sector consisted largely of
small and low technology artisans and farmers, this private investment
boom was driven by incoming investments of overseas Palestinians
who began to invest in the tourism sector, in telecommunications
and in related service sectors. Those who visited Ramallah or
Bethlehem over this period could not have failed to notice the
large number of quite decent hotels that were springing up almost
overnight. This story, we believe, has not been adequately told
or understood, and it provides a glimpse of what the Palestinian
economy could have achieved under different external conditions.

Also interesting is the fact that aid as a share
of GDP was on a persistent downward trend throughout this
period. The main impact of this was on public investment
that began to decline from 1997 onwards, as shown in the fourth
row of our table. While this was undesirable given the weakness
of public infrastructure and the political instability of the
times, the growth figures also show that the Palestinian territories
are not necessarily heavily aid dependent, and that considerable
autonomous economic development is potentially possible if expatriate
Palestinian capitalists can be harnessed to play a role in developing
the Palestinian economy.

PALESTINIAN ECONOMIC TRENDS DURING THE OSLO
PERIOD

1994

1995

1996

1997

1998

1999

2000
(p)

Real GDP Growth

8.5

-2.4

-3.2

4.8

7.0

6.0

-1.5

Real GNI Growth

0.9

-4.3

-4.6

7.6

11.9

7.2

-4.9

Real Private Fixed Investment Growth

na

5.0

-5.0

5.0

11.3

19.0

-12.2

Real Public Fixed Investment Growth

na

10.0

15.0

20.0

-3.0

-13.0

-17.1

Aid as Proportion of GDP(%)

18.0

17.6

15.0

14.0

10.0

10.0

na

Unemployment Rate

14.8

18.2

23.8

20.6

13.2

11.8

14.1

We analysed the Palestinian Authority and its different,
and sometimes contradictory governance characteristics in the
context of its specific economic and political environment. Given
the transitional nature of the Authority, we could only look for
incipient characteristics whose further development might define
different "types" of state, and we looked for the institutional,
political and external conditions that sustained these characteristics
and/or could lead to their change or further consolidation. Not
surprisingly, we found elements of institutional and political
characteristics that could potentially support very different
types of states, defined in terms of their economic and political
features. The further development of these features would depend
on how political and institutional conditions developed. For convenience,
we refer to these possibilities as a client state, a predatory
state, a fragmented clientelist state, and a developmental
state.

CLIENT STATE
CHARACTERISTICS

Many of the characteristics of the Palestinian Authority
could be described as characteristics of a client state (of Israel).
This was reflected in the agreements the PLO signed at Oslo, in
the Paris Protocol, and other treaties. These allowed Israel not
only to restrict the defence capacities of the PA, but also to
determine its international trade, ensure its fiscal dependence
on taxes collected from Palestinians by Israel, control its international
borders and internal checkpoints for an indefinite period, and
so on. The political imperatives that forced the PLO to this route
are well known, and follow from Israel's insistence on "security-first",
namely that until Israel is assured of its security, it will insist
on retaining sovereign powers within the Palestinian territories.
This condition was understood and implicitly accepted by the Palestinian
leadership and a considerable coalition of interests within the
West Bank and Gaza that provided the constituency for Arafat's
programme.

However, while the principle was widely accepted, compliance
by a client state can be ensured through very different strategies,
and we find that Israel's contradictory strategy after Oslo contributed
to make progress unviable. This incoherence in Israeli strategies
is likely to block progress under the new Road Map. We distinguish
between two types of strategies that could ensure that a Palestinian
client state remained compliant with the security interests of
Israel. The first can be described as an integrationist
strategy. This would involve a gradual but progressive opening
up of capital and labour markets, such that the economic interests
of the two states become convergent, and incentives were
created that would prevent actions by the client state against
the interests of the dominant power. This strategy was outlined
by Peres in his book The New Middle East and some moves
were made in this direction in the form of joint Israeli-Palestinian
investments (for example, the Jericho casino, Israeli investments
in some Palestinian companies, and some Israeli subcontracting
to Palestinian companies in the Gaza strip). Potentially, economic
integration may have allowed the Palestinian economy to grow sustainably,
and would have been economically beneficial for the Israeli economy
too. However, these moves rapidly came to an end, and in the critical
area of labour mobility, the moves were in the opposite direction
from the outset, with significantly increased restrictions from
the signing of Oslo onwards. We find it difficult to explain these
restrictions in terms of security concerns alone. Although there
were sporadic acts of violence on both sides after Oslo, these
were both expected and actually quite limited in the early years
when there was widespread goodwill and optimism on both sides.
Integration may have provided significant dividends in the long
term. In our opinion, the unstated problem that drove the closure
of the integrationist route is a political rather than a security
problem. As the EU experience shows, economic integration
leads (sooner or later) to gradually increasing political
integration and this threatens to defeat the purpose of the two-state
solution from the Israeli perspective. If the Palestinian population
of the territories occupied in 1967 are added to the Israeli Palestinians
who already have political rights in Israel, the Jewish-non Jewish
balance is already 50-50, and is likely to become 40-60 in the
next couple of decades. If this political obstacle is going to
prevent any meaningful progress towards economic integration in
the Middle East, this has critically important implications for
external aid and donor policies.

The initial moves towards integration were not followed through,
and instead there was a rapid shift to a strategy of asymmetric
containment. In contrast to integration, here the goal is
to enforce compliance by creating huge penalties for non-compliance.
Amongst the mechanisms that were consistent with this strategy
were new and intrusive restrictions on the movement of labour,
retaining control over key roads and checkpoints within
the territories, the control of international borders and the
ability to delay imports and exports, retaining control of Palestinian
fiscal revenues and determining the timing of their release, and
so on. By the end of the period, although economic growth took
off, led by new external drivers, the vulnerability of
the Palestinian economy had increased as a result of institutional
changes that gave Israel the power to shut off the Palestinian
economy at short notice; an ability that was demonstrated rapidly
when the second intifada began. In contrast to the integrationist
strategy, a client state strategy based on asymmetric containment
exposes the client to perpetual economic vulnerability, and is
not likely to be politically acceptable to a people aiming to
achieve greater sovereignty. It is important to recognise that
key features of asymmetric containment were likely to continue
under the "final offer" that Arafat rejected at Camp
David. As a Palestinian negotiator put it: "In a prison,
the prisoners control 95% of the space. It is the 5% they do not
control that make it a prison".

It is important to recognise that many of the apparent governance
failures of the Authority were a direct consequence of the design
features of the Oslo constitution that intended to create
a client state with a strong executive with limited accountability.
All parties recognised in 1994 that pushing through a two-state
solution against the strong opposition of some Palestinian minorities
would require an emphasis on security apparatuses and a strong
executive. Our assessment is that this was not necessarily a mistake,
and in terms of what the Authority was supposed to achieve, its
initial performance in security and development was not bad. However,
the problem was that the asymmetric containment version
of the client state was structurally unviable in the sense that
imposing it on the Palestinian population eventually threatened
to cost too much in terms of the suppression of a Palestinian
opposition. Far from this being a ploy of Arafat, an objective
analysis suggests that imposing a client state with asymmetric
containment is likely to be politically impossible for any leadership
of the future. This conclusion too is likely to be of interest
to external donors and the hopes that are being pinned on an eventual
change of the Arafat leadership. If anything, a post-Arafat leadership
is likely to find adherence to any client state strategy
much more difficult.

Once the economy is perceived to be unviable, this has implications
for the strategies of political players and the political leadership.
Even a well-intentioned political leadership would then be likely
to descend into either a predatory mode, or to fragment into versions
of fragmented clientelism, since it is not possible to seek power
or wealth through economic development. Alternatively, depending
on its opportunities, economic constraints can result in greater
state efforts at pushing development. Characteristics of all these
types of states could be found in embryonic form in the Palestinian
Authority, and our project examined the conditions under which
each of these combinations of characteristics are likely to be
furthered.

PREDATORY STATE
CHARACTERISTICS

A predatory state is one that extracts resources from its
citizens to enrich state officials; but at such a rate that economic
growth is lowered or even made negative. We typically find such
states in contexts where economic growth is difficult to trigger
anyway, for instance because of social resistance, the under-development
of capitalists and the infrastructure they operate with. Many
of the instances of petty corruption and extortion of bribes from
businesses observed in the Palestinian Authority are consistent
with a predatory state. However, while these issues needed to
be addressed, the PA compares favourably with other developing
countries. This is surprising given the uncertain context in which
the Palestinian Authority operated, but it can be explained by
the development options available to the executive. These options
were not poor to the extent that predation became the more profitable
option. Nationalism may also have helped, as it has in a number
of East Asian countries. But most importantly, the availability
and willingness of expatriate Palestinian capitalists to return
to Palestine played a key role in determining better strategies
for the political leadership.

FRAGMENTED CLIENTELIST
CHARACTERISTICS

Another variant of state failure is observed when competing
(patron-client) factions within a developing country are strong
but fragmented, and productive opportunities are limited. In this
scenario, competing factions are likely to seek redistribution
rather than policies to enhance growth. This is a very common
scenario in developing countries, where the competing demands
of powerful factions can serve to paralyse the state, and we describe
this as fragmented clientelism. The large redistributive transfers
made by the PA to maintain political stability had some characteristics
of fragmented clientelism. The administrative structure, and the
security apparatus in particular, probably employed more than
a few people who had to be accommodated for reasons of political
stabilisation. While these problems were real enough, the Palestinian
Authority did not suffer from these redistributive demands to
the same extent as many other developing countries. Not only was
executive power sufficiently centralised to prevent redistributive
demands going out of hand, Palestinian civil society was, paradoxically,
too fragmented to allow the consolidation of factional parties
along the lines of many developing countries that face severe
constraints as a result of clientelism.

DEVELOPMENTAL CHARACTERISTICS

Most surprising was our finding that in response to asymmetric
containment, the PA engaged in a number of interventions that
in the Palestinian context amounted to developmental interventions.
Here, we did not apply any textbook notion of the conditions that
encourage investment, but rather we looked at the evidence of
developmental states in East Asia that were successful in encouraging
investment in climates that were otherwise adverse for investors.
Historically, this has often involved necessarily non-transparent
incentives for investors, granting them temporary monopolies,
or otherwise augmenting profitability to encourage investment
and risk-taking, while disciplining investors who did not perform.
The Palestinian Authority had virtually no fiscal powers to give
incentives to investors, but it did allow the setting up of monopolies
that enhanced profits for critical investors, granted them tax
breaks and other incentives such as delayed payments of utility
bills. It also shared some of the profits of these enterprises,
both legally, as the Authority owned shares in many of these enterprises,
but also illegally, in the form of kickbacks that augmented the
off-budget resources that were vital for regime survival in a
context of fiscal control by Israel. Critically, it showed itself
able to change the allocation of contracts if opportunities that
were more productive emerged, since the institutional and political
conditions meant that the executive had no interest in knowingly
tolerating inefficiency. This system cannot be described briefly,
but while it certainly had costs and disincentives, its net effect
was to attract vital investments by overseas Palestinians in a
context of tremendous uncertainty in an area whose final status
was not clear, and where property rights were ultimately controlled
by Israel. These interventions had the appearance of governance
failures but they were important for explaining the reasonably
good economic performance in the final years of Oslo, despite
a tightening of asymmetric containment.

Thus, we differentiate between three different types of governance
failures observed in the PA. First, there were apparent governance
failures that were directly the result of the design of the Oslo
Architecture. Examples of these include petty corruption at border
posts, since an excessive number of checkpoints were constructed,
excessive expenditure on security and security personnel, and
executive centralisation. These were arguably necessary costs
of trying to construct a client state. They did have negative
economic effects, but these failures were not in the control of
the PA. It may be very difficult to address these governance issues
within the context of a client state strategy.

Secondly, there was clearly a range of internal failures
of the PA. These included instances of petty corruption by security
officials, extortion by officials, and a centralisation of decision-making
beyond what was necessary in the circumstances. The leadership
could have addressed the negative effects of these failures. If
a client state strategy is to be pursued in the future, attention
should be focused in these areas.

But finally, there were apparent governance failures that
were associated with the Palestinian leadership's attempt to break
out of its asymmetric containment by pursuing developmental strategies
and enhancing its own economic flexibility. These strategies included
maintaining secret funds, promoting Palestinian trading monopolies
as counterparts of Israeli trading monopolies, granting special
privileges to Palestinian expatriate investors, including temporary
monopolies, and so on. These interventions paradoxically enhanced
the viability of PA and allowed economic development in the territories
that was faster than might otherwise have been the case. It follows
that attempting to change these governance characteristics
without addressing asymmetric containment and broader issues of
accelerating development may actually be counter-productive. This
too is an important conclusion for donors and aid strategies.

CONCLUSIONS

Oslo has been important for establishing that any external
assistance for conflict resolution and economic development can
only help if it comes with a clear picture of the "final
status" that is to be achieved. Here final status has to
be defined not only as territorial boundaries (which are critical
for determining the political viability of any future Palestinian
entity) but also its proposed economic sovereignty. The openness
of Oslo with respect to a number of potential outcomes eventually
led to its failure. The diagram below summarises some of the arguments
we make about state characteristics and how they developed. The
most important point to make in this brief submission is that
the client state strategy (though it was not called that by any
party for obvious reasons) was accepted by both sides in 1993
as the only viable way forward. But the Palestinian constituency
behind Arafat would not accept asymmetric containment, and Israel
would not proceed with economic integration. This raises a fundamental
challenge for any road map of the future. There are unlikely to
be conditions as favourable as in 1993-94 for attempting a client
state based on economic integration, and we have provided a demographic
explanation of why Israel rejected this route. Our analysis suggests
that the only other possibility of constructing a two-state solution
would be an immediate move towards a fully sovereign Palestinian
state on international (1967) borders with no territorial exceptions.
The problem of exceptions in the form of settlements and East
Jerusalem is that a Palestinian constituency would not be found
that was big enough to enable a viable state to be formed. If
a "Green Line" Palestinian state could be formed, security
for Israel would then have to be internationally guaranteed, rather
than guaranteed by maintaining the Palestinian state in client
status. Our analysis suggests that while the loss of employment
opportunities in Israel would hurt, the presence of expatriate
Palestinian capitalists means that even a state with PA governance
characteristics could very soon become reasonably viable with
full sovereignty and separation from Israel. If a Green Line state
proves not to be possible, a demographic shift is likely to hit
Israel within a couple of decades if not sooner, and rational
Palestinians will begin to demand civil and voting rights instead
of land. This strategy may have its own merits but was outside
the remit of our project.

In the meantime, the post-intifada Palestinian economy has
fragmented by design because of Israeli closures. In the interim,
survival in Palestinian enclaves has come to depend on aid, remittances,
income sharing and a return of the population to the land and
to a more basic economy. This is clearly not a viable situation
for too long, but Sharon's administration may hope that the Palestinian
polity will also fragment and then it may be possible to separately
administer Palestinian regions under regional political leaders.
We describe this strategy as "bantustanization", and
it may be that this will now continue for some time. It is, of
course, not a permanent or viable solution, and its only effect
will be to make the two-state solution even less likely. This
is so because the land on which the Palestinian state can be constructed
is steadily being lost, and the population balance is shifting
to an extent that Palestinians have more to gain by demanding
civil and voting rights instead of an unviable state. It may already
be too late, but our analysis suggests that in any case donors
have to be careful not to let Israel shift into a bantustanization
strategy by uncritically allowing aid to be used to sustain unviable
enclaves. Even if aid has to flow for humanitarian reasons, each
tranche should be time-bound and its renewal should be an occasion
for pressuring Israel to accept its responsibilities for the people
living under its control. The analysis and case studies backing
up this memorandum are due to be published as a book by Routledge
as I have already indicated[253].
However, pending publication, I will be happy to provide the committee
with further information if required.